AT&T's (NYSE:T) planned $85 billion acquisition of Time Warner (NYSE:TWX) recently hit a speed bump after the US Justice Department sued to block the deal. The DOJ previously warned AT&T that it would likely need to divest Time Warner's Turner Broadcasting -- the parent company of CNN -- to win regulatory approval.
The DOJ is concerned that the combination of AT&T's wireless, home internet, and pay TV businesses with Time Warner's media assets would create an anti-competitive ecosystem that would limit consumer choices. It also believes that the merger could hurt online video competitors like Netflix (NASDAQ:NFLX).
IMAGE SOURCE: AT&T.
Why AT&T wants Time Warner
AT&T is America's second-largest wireless carrier, top wireline services provider, and biggest pay-TV provider thanks to its purchase of DirecTV in 2015. AT&T is bundling many of these services together (like unlimited wireless data and DirecTV streaming plans) to widen its competitive moat.
Adding Time Warner's content -- which includes Warner Bros., HBO, CNN, and other cable networks -- to that ecosystem would allow AT&T to control both the pipes and the content. This makes it a major threat to Netflix, which has great content but isn't a wireless carrier. It could also hurt rival carriers like T-Mobile (NASDAQ:TMUS), which offers competitive wireless plans but doesn't own a portfolio of media content.
For example, AT&T recently announced that it would give free HBO subscriptions to its Unlimited Choice customers, who pay $60 per month for unlimited data, talk, and texting capabilities. Customers who already subscribe to its DirecTV or U-verse plans would get HBO as an extra channel, while non-pay-TV customers would gain access through its DirecTV Now and HBO Go apps.
These bundling strategies could offset AT&T's sluggish growth in video and wireless subscribers, which both fell year-over-year last quarter, and help lock in new customers.
What the Justice Department believes
The DOJ has been down this road before. Back in 2011, it approved Comcast's (NASDAQ:CMCSA) merger with NBC Universal without requiring it to divest any major assets. But when Comcast subsequently tried to buy Time Warner Cable, regulators threatened to block the deal, which was eventually abandoned in 2015.
The DOJ opposed the deal on grounds that it would give Comcast too much control over the pipes and the content, the same issue which AT&T and Time Warner now face. At the time, the DOJ stated that the merger "would make Comcast an unavoidable gatekeeper for Internet-based services that rely on a broadband connection to reach consumers."
However, Trump's DOJ antitrust chief, Makan Delrahim, has flipped-flopped on the AT&T/Time Warner merger before. Last October, when he was still the deputy assistant attorney general at the DOJ, Delrahim told Canada's BNN that the deal didn't represent "a major antitrust problem."
Yet the DOJ now calls the merger "a weapon to harm competition", which would result in "fewer innovative offerings and higher bills for American families." Delrahim's change of heart seemingly mirrors President Trump's declaration that the deal is "not good for the country," fueling speculation that the move against AT&T could be related to his long-running feud with CNN.
Should AT&T investors worry?
AT&T now faces a long legal battle, in which it will need to allay concerns that the deal would harm the competition and raise prices for consumers. That could prove tough since AT&T previously emphasized the combined ecosystem's "complementary strengths" and touted it as an attractive "alternative to cable and other video providers" in corporate announcements regarding the deal.
AT&T believes that the deal, which could boost its long-term debt to over $180 billion, will become accretive to its adjusted earnings and free cash flow within the first year. But if it gets blocked or certain key assets (like Turner Broadcasting) are forcibly divested, the benefits could be far less impressive.
Investors shouldn't fret over the lawsuit for now since AT&T's stock is still cheap at 12 times earnings and it pays a hefty forward dividend yield of 5.7%. But I also wouldn't expect the stock to rebound until the lawsuit is resolved.
Newly released! 10 stocks we like better than AT&T
On November 10, investing geniuses David and Tom Gardner revealed what they believe are the ten best stocks for investors to buy right now… and AT&T wasn't one of them! That's right -- they think these 10 stocks are even better buys.
And when the Gardner brothers have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*